Monday, February 06, 2017

Demonetisation: Penalty of equal amount on cash transactions greater than Rs. 300,000!

After the budget, Finance Secretary spoke to TV channels and clarified that Government will be imposing 100% penalty for accepting cash greater than Rs 300,000/- per transaction. The penalty will be levied on the receiver. Mint has an article reporting this.

Immediately a few thoughts came to mind:
  1. This move is trying to choke the points through which black money becomes white in large sums but few transactions. Example, purchase of luxury cars, watches, exotic items like liquors etc. Such businesses have no reason to be in cash except to serve the black economy fellows.
  2. There are still points where we have black money exchange is based on small sums but large transactions. This is excluded. Most of these transactions may be legitimate cash transactions in the white economy and it would be impossible to differentiate between legitimate and black money transaction in this space. An example could be payments made to the large contract labour force.
  3. Now imagine normal businesses such as eateries which collect most of sales through cash transactions. These eateries cannot make payments above Rs. 300,000/- to their vendors using cash. It means they necessarily deposit the cash into the bank and then push it through the electronic pathways.
  4. Allowing such businesses to work is humane. But it also serves another advantage. If the government wants to move to a less-cash economy, these businesses will suck out the cash from the system gradually.
  5. At the same time, the black money holders use this mechanism to launder money. The modus operandi is simple, open a saloon or service shop. This shop does not sell any product with upstream or downstream purchases required. It simply sells services. Imagine a wellness spa. This spa has a large number of fictitious customers who make payments of Rs. 2000 or so per transactions. The spa employs few employees - for argument sake - one masseuse. This fellow does more than 100 massages (!!) per day to launder 200,000/- per day. You can tweak the numbers based on your fancy. The owners get the share of profits based on the equations you use. Now comparing the employee productivity with legitimate massage centres can expose these easily.
  6. So now the government is isolating the black economy from the white economy. I assume the white economy will get all sorts of benefits while the black economy will get penalties. Going by honest-friendly orientation.
The government has made an interesting move. Small move big impact seems to be the new motto. The next steps to demonetization seem to be in the works. In the budget, we also got some glimpses of the benefits. V. Aanatha Nageswaran has a super post on that.